Conventional loans provide the least expensive and most valuable mortgage instrument for the long-term. You can buy pretty much anything you’d like to buy, whether that’s a fixer-upper or a new construction home, and the fees are much lower than other products.
Conventional Mortgage Basics
A “conventional, conforming” mortgage is kind of the cream of the crop when it comes to home loans, but what makes it conventional and whose rules is it conforming to? Being a conventional, conforming loan means that this particular loan will be purchased by the Federal National Mortgage Association (otherwise known as Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac) because it meets their requirements for purchase. These rules change yearly, generally in the fall. The main change, year after year, is to the upper loan limits.
For 2018, the conventional loan limit in most parts of the United States is $453,100. Areas designated as “high-cost” have higher rates, like Alaska and Hawaii, where limits may meet or exceed $679,650 for a single-family home because housing is so much more expensive.
Anything above that limit is known as a jumbo loan, which is usually a conventional, non-conforming loan. Fannie and Freddie aren’t that into jumbos, so they leave them be and they’re instead sold to private investors or held by the banks that initially wrote them.
A Little History of Fannie and Freddie
Fannie and Freddie were both created as a response to the fact that most mortgage borrowers had little available cash. Fannie was a product of the Great Depression, created as part of the New Deal, and essentially birthed the secondary mortgage market. Mortgages are often sold onto the secondary market to free up capital for banks so they can continue lending to house-hunters. Fannie, then, enabled more Americans to get into homes of their own in an era when people were defaulting on their mortgages left and right.
Freddie was created in 1970 as a direct competitor to Fannie Mae. There were concerns that Fannie’s 1968 privatization would ultimately hurt home buyers, but both are now under conservatorship by the US federal government and function in basically the same way. Whether your loan is bought or guaranteed by Freddie Mac or Fannie Mae, it’s still a conventional conforming loan with terms that are most likely identical.
Pros and Cons of Conventional Mortgages
A conventional mortgage is typically the best choice for a home buyer, if they can qualify, but they’re not perfect for everyone. This handy chart will help you tease out the nuance.
Benefits of a Conventional Mortgage
- Conventional home loans may have lower down payment requirements. Some lenders allow down payments as low as 3% on conventional loans.
- Conventional home loans can allow you to buy more than a primary home. Unlike some kinds of loans (ex. FHA and VA loans), conventional mortgages allow you to purchase vacation and investment homes.
- Conventional mortgages may have more flexible terms: When compared to FHA loans or jumbo loans, conventional mortgage borrowers may be able to have more flexibility, especially when it comes to the length, or term, of their loan.
- Loan size limitations. As mentioned previously, a conventional mortgage can only get you a home loan of a certain size, depending on the state and county in which you live.
- Higher credit score requirements. Conventional mortgages typically require the borrower to have a credit score of at least 620.
- Debt-to-income (DTI) ratio requirements. Conventional home loans also require borrowers to have a specific DTI ratio (a borrower’s monthly recurring debts divided by their monthly income). To get a conventional loan, your DTI usually needs to be well below 50%.
Drawbacks of a Conventional Mortgage
Who’s the Ideal Borrower for a Conventional Loan?
Anyone and everyone is a great borrower for a conforming conventional loan, but there are some buyers who are more ideal than others. These buyers are:
- Established, just like their credit file.
- Plan to keep the home for a long time.
- Have few other outstanding debts.
- Are experienced homebuyers or are at least willing to hire experts to look over their prospective home.
- Married couples with a spouse that cannot qualify for the loan, which means their credit and their income will be verified.
Often, a conforming conventional loan can end up being the best deal you’ll get on a mortgage because they’re only offered to borrowers who represent very little risk. They also come with much lower mortgage insurance rates than are generally available under other programs.
If you’re looking at a conventional loan, always do so with caution. Some of the worst loans that came out of the mortgage crisis of the mid 2000s were considered non-conforming conventional loans. With so many options available, it can be easy to get confused about which is which. Non-conforming conventional loans can sound like amazing deals — and they usually are, at first. However, at a certain point, terms start to change or a massive balloon payment pops up.
Newer loan disclosures make it easier to spot these types of loans, however. Always read everything before you sign it, especially if you’re dealing with a lender who works with many different banks (a broker) as opposed to a banker at the bank where you have your checking account. Brokers can offer many types of loans bankers don’t typically have access to, which can be both good and bad, depending on your situation.